This editorial originally appeared in the Wall Street Journal on November 16, 2020.
One of the stakes in who controls the Senate in 2021 is the fate of the Trump Administration’s deregulation project. A GOP Senate could block Democrats from using of the Congressional Review Act to overturn important rules. A valuable case in point is the new Labor Department rule requiring that retirement plan managers invest in the best financial interest of their beneficiaries.
Last month DOL finalized a rule underlining that the Employee Retirement Income Security Act (Erisa) requires plan fiduciaries to act “solely in the interest” of plan participants “for the exclusive purpose of providing benefits” and “defraying reasonable expenses.” In other words, managers can’t prioritize their own pecuniary or political interests.
This shouldn’t be controversial. The Supreme Court unanimously ruled in Fifth Third Bancorp v. Dudenhoeffer (2014) that Erisa’s reference to benefits signifies “financial” rather than “nonpecuniary” benefits. For example, a fiduciary can’t invest employees’ retirements exclusively in their own employer’s stock if the “financial goals demand the contrary,” Justices explained.
A fiduciary also can’t invest retirement assets only in companies with low carbon emissions or racially diverse workforces when these aren’t linked to financial returns. The Labor rule clarifies that financial factors are those that have a “material effect on the return and risk of an investment.”
Asset managers like BlackRock, Fidelity and Vanguard say ESG funds perform better over the long-term, but the evidence is spotty. A Pacific Research Institute study last year found that the S&P 500 outperformed a broad basket of ESG funds over a decade by nearly 44%. One reason is many ESG funds excluded companies like Amazon, Netflix and Mastercard
BlackRock in a public comment cites a 2015 Harvard Business School study that found firms with strong ratings on material sustainability issues had better future performance than firms with lower ratings. Ok, but if that’s the case, CEO Larry Fink and other asset managers shouldn’t have a problem complying with the new Labor rule
Their problem is that they consider political rather than economic risks—for instance, from a Biden Administration imposing more climate regulation—that they assume financial markets don’t account for in stock prices. Many factors they deem to be “material” risks are also not clearly linked to financial performance.
Take the Sustainability Accounting Standards Board, which is BlackRock’s ESG north star. SASB considers a company’s behavioral advertising, plastic consumption and revenue derived from selling no-added-sugar and artificially sweetened drinks “material.” Is bottled Glaceau Smartwater a material risk to Coca-Cola ? It has zero sugar (good), but, OMG, it’s made with plastic.
Notwithstanding the recent plunge in oil prices, BlackRock’s S&P 500 Growth ETF beat its Clean Energy ETF by an annual average of more than 10 percentage points for the five years ending May 15, according to the Institute for Pension Fund Integrity. BlackRock says ESG funds during the first quarter significantly outperformed broader indexes.
Well, yes. That’s because stock prices of energy companies have plummeted during the pandemic amid lockdowns while those of tech companies (which are weighed heavily in many ESG funds) have soared. But fiduciaries are supposed to consider long-term returns.
The reason asset managers largely oppose the new Labor rule is because they want to use worker retirements to promote their own political and financial interests. They want to charge higher fees for managing ESG funds even if they don’t produce better financial returns for beneficiaries. The DOL rule forbids them from doing that. Kudos to Labor Secretary Gene Scalia for standing up to these Wall Street complaints.